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March 2, 2012

Fellow Advisors, All Your Models Are ‘Garbage’: John Mauldin

After the developed world, and eventually even the U.S. government, deleverages, asset allocation models can be brought back

John Mauldin and the cover of his recent book, "Endgame."

“All those models you use” to track business cycles and determine your investing strategies, says newsletter and book author John Mauldin, are “all garbage now” and “no longer work.”

However, he counseled his fellow advisors in a general session at the first annual Shareholders Service Group conference in San Diego on Thursday, “after deleveraging is over in four to five years, things will start happening ‘normally’ again” so advisors can bring back their asset allocation models.

Mauldin is president of Millennium Wave Advisors and publisher of a popular weekly electronic newsletter, Thoughts from the Frontline, and is also author of several books, including the recent “Endgame: The End of the Debt Supercycle.” He noted in his presentation to a receptive audience that leverage could be “a good thing on the way up,” but that over-leverage in the developed world, particularly in the U.S. and Europe, has changed the economic and investing equation. While he argues that U.S.-based banks and corporations have successfully made steps to deleverage themselves, “our government hasn’t even started” the process, and that a number of European countries and banks remain highly vulnerable.

He reserved special scorn for the president of the European Central Bank, Mario Draghi, repeating a joke that “you know something is wrong in Europe when the Pope is German and the head of the ECB is Italian.” He expects Greece in particular to embrace one of two possible “disaster” scenarios: the first would be to stay in the Eurozone and accept the draconian measures imposed by the ECB and spurred on by the German government, whose banks have reduced their Greek exposure; the second would be for the country to leave the eurozone and resurrect the drachma. The second scenario, he suggested, might be the result of the Greek electorate deciding to change its political leadership because it accepted the ECB’s ultimatums.

In Europe, however, he believes that “in three years, we’ll be talking about France like we’re talking today about Greece and Italy now,” arguing that what the French like to think of as their unique social contract is unsustainable. Showing that anti-French sentiment is alive and well, the audience seemed to react favorably to the idea of tough times ahead for France.

As for coming economic basket-cases, he believes Japan may be the “next problem,” particularly if interest rates rise. If Japanese government bond rates rise only 2%, which he said was entirely possible considering its weakened economy, 79% of Japan’s tax revenue would go only to meet its interest rate payments. Japan, he said, is a “bug looking for a windshield.”

As to how to avoid future crises like 2008-2009 and the current European sovereign debt story, he recommended advisors read economists Carmen Reinhart and Ken Rogoff’s book, “This Time It’s Different.” Those authors, he said, looked at 250 financial crises that occurred throughout history in 66 different countries. The key, he said, is whether debt is excessive relative to income. That’s because, Mauldin argued, that “whether the debt is public or private, the private sector will be paying the debt.” And on the day he spoke, the government reported that personal disposable income was down in the latest reading, after inflation, suggesting that we're not out of the woods yet.

The only way to grow GDP, he concluded, is to increase productivity and increase population. With their very low birth rates and restrictive immigration policies, much of southern Europe in particular and especially Japan will have a hard time to grow their economies.

As for the U.S., he believes that by 2013 American politicians will be forced to act to reduce the deficit. The best case scenario, he hopes, would be to slowly raise taxes over a 10-year time period to help fix our debt-to-GDP ratio, while also encouraging immigration, particularly from well-educated, well-off people from around the globe. And for those international students who attend U.S. universities, he only half joked, he would hand them “a green card attached to their diploma.”

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